Can Enterprise Value Be Negative? And What About Equity Value?

Why “Free Companies” Aren’t Really Free

Can Enterprise Value or Equity Value Be Negative?

• SHORT ANSWER: “Yes, but…”

• BUT: We need to be more specific with the terminology and qualify this statement a bit more

• Enterprise Value: Value of core-business Assets to all investors in the company

• Equity Value: Value of all Assets, but only to common shareholders (equity investors)

• Equity or Shareholders’ Equity: Balance Sheet figure – no market value

Can Enterprise Value or Equity Value Be Negative?

• Current vs. Implied or Intrinsic: “Current” refers to the company’s Equity Value or Enterprise Value based on its public share price, and it represents the market’s views of the company’s value

• Current Enterprise Value: Yes, it can be negative

• Implied Enterprise Value: Yes, it can be negative

• Current Equity Value: No, it can’t be negative (in theory)

• Implied Equity Value: Yes, it can be negative

• Equity or Shareholders’ Equity: Yes, it can be negative

Can Enterprise Value or Equity Value Be Negative?

• Part 1: How Enterprise Value Can Be Negative

• Part 2: How Implied Equity Value Can Be Negative

• Part 3: The Qualifications and Fine Print for “Negative” Enterprise Values and Equity Values

How Enterprise Value Can Be Negative

• Enterprise Value: Can easily be negative! People even screen for companies with negative EVs as an investing strategy:

• And: Applies to both Current and Implied – if a negative EV is observable in nature, your views of the company can also create it

How Enterprise Value Can Be Negative

• How? Public company has a Market Cap, no Debt, and some Cash, and Cash > Market Cap:

• Your Response: “That makes sense mathematically, but what does it mean? How can a company’s core-business Assets be worth a negative amount? That makes no sense!”

How Enterprise Value Can Be Negative

• ANSWER: If those Assets generate negative cash flow in the future

• Company Value =

Cash Flow

(Discount Rate – Cash Flow Growth Rate)

Where the Cash Flow Growth Rate Must Be < Discount Rate

• So: If Cash Flow stays negative forever, Implied EV will be negative

• BUT: Let’s avoid controversy and show you how this could work even if Cash Flow is positive and everything is normal in the Terminal Period

How Enterprise Value Can Be Negative

• So: Even if the company’s Cash Flow eventually turns positive and stays that way, Implied EV could still be negative

• Why: The Present Value of what you put in to keep the company running exceeds the Present Value of the cash flows you earn back

• Or: If Cash Flow stays negative forever, the company is worthless today… AND you have to contribute cash to keep it running!

• Real Life: Companies like Uber or Snap that keep growing but also keep losing more money over time… turnaround in sight?!!

How Implied Equity Value Can Be Negative

• “Equity” can mean many different things, and the names are confusing

• Shareholders’ Equity or “Equity”: Balance Sheet figure that can easily be negative since Net Income and Dividends flow into it

• Current Equity Value: In theory, this cannot be negative for a public company since it equals Share Price * Shares Outstanding

• But: Implied Equity Value could be negative – take a look at that simplified DCF for the startup to see it!

• Intuition: Similar Put in a lot of cash and get little, if anything, back

The Fine Print and Qualifications

• “Possible” does not mean “Plausible”

• It’s possible for Any Enterprise Value and Implied Equity Value to be negative… but they rarely stay negative for long

• Most Companies: Market’s views turn around, and they succeed, or… they go bankrupt and die

• Intuition: How long can a company last if its core business is worthless?

• Real Life: Often, you’ll just set the company’s Implied Share Price to $0 if you get this result in a valuation, and you’ll look to other methodologies

Recap and Summary

• Shareholders’ Equity or Equity on Balance Sheet: Yes, this could easily be negative, and it’s almost always a negative sign

• Equity Value: Current Equity Value for public companies cannot be negative because it = Share Price * Shares Outstanding…

• But Implied Equity Value might be negative, depending on assumptions

• Enterprise Value: Both Current and Implied Enterprise Value could be negative

• Qualifications: These cases are rare, and they don’t last long

Recap and Summary

• Meaning: You expect or the market expects the company to generate negative cash flow into the future – and your contributions into the company are worth more than what you earn from it

• Most Cases: Negative Equity Value or Enterprise Value means you shouldn’t even be using traditional valuation methodologies

• Bargain? If a company has a negative Enterprise Value, you could buy its shares for less than its Cash per Share… great, right?

• Fine Print: Well… not really. Company doesn’t have to distribute that Cash to you! Could just burn through it all